Key events of state election results and Fed rake hikes have passed and the bond market has only the RBI April policy to look forward to now for yield direction. Both the state election results and the Fed rate hike have largely been more positive than negative for the 6.97% 2026 bond yield with the Modi government’s strong showing leading to the government staying on fiscal consolidation path and Fed guiding for gradual rather than faster pace of rate hikes.
RBI is likely to keep rates status quo in its April policy meet. Given that the 6.97% 2026 bond yield has risen by 70bps from lows seen in November 2016 and the fact that there is no great driver for the bond yield, the bond will trade in a tight range at around current levels of 6.85%. This will not give any money making opportunities for bond traders and they will have to look elsewhere along the yield curve or credit curve to make money.
The government bond yield curve is flat in the 5 over 10 segment of the curve with both 5 year and 10 year gsec yields trading at 6.86% levels. The yield curve is steep in the 10 year over 15 year and 30 year segment. Spreads are at levels of around 60bps and 80bps respectively. Given that repo rate is expected to stay stable at 6.25% levels for most of this year, markets will start to buy into higher spreads for both carry and gains from spread compression.
Credit spreads too are attractive for 10 year AAA bonds at levels of 100bps. Levels of around 8% for the 10 year AAA corporate bonds offer both safety and carry for the market. Spreads will come off as markets search for yields.
INR has rallied by over 2% against the USD to trade at levels last seen in October 2015 post the state elections results and Fed rate hike. Sensex and Nifty are at record high levels and expectations of capital inflows will be strong. Appreciating INR will bring in FII investments into credits leading to spread compressions.
The ten year benchmark bond, the 6.97% 2026 bond saw yields fall by 4bps week on week to close at levels of 6.86%. The old ten year benchmark bond, the 7.59% 2026 bond saw yields fall by 9bps to close at 7.05% levels while the 7.88% 2030 bond saw yields fall by 12bps to close at 7.46%. The 8.13% 2045 bond saw yields fall by 1bps to close at 7.63%. Bond yields will be ranged till RBI policy in April.
OIS market saw one year OIS yield fall by 2bps and five year OIS yield fall by 7bps week on week. One year OIS yield closed at 6.42% while five year OIS yield closed at 6.64%. OIS yields will stay ranged till RBI policy in April.
Credit spreads closed higher last week. 10 year benchmark AAA bond yields closed higher by 2bps at 7.98% levels with spreads up by 6bps at 100bps Benchmark 3 year AAA corporate bond yields closed higher by 5bps week on week at 7.43% levels. Credit spreads rose by 13 bps to close at 67bps levels. 5 year benchmark AAA bond yields closed flat at 7.68% with spreads up 6bps at 70ps levels. Market will look to buy into spreads at higher levels given strong system liquidity, stable repo rates and appreciating INR.
System liquidity as measured by bids for Repo, Reverse Repo, Term Repo and Term Reverse Repo in the LAF (Liquidity Adjustment Facility) auctions of the RBI and drawdown from Standing Facilities (MSF or Marginal Standing Facility and Export Credit Refinance) and MSS bond issuance was in surplus of Rs 4129 billion as of 17th March 2017. The surplus was Rs 5100 billion in the week previous to last. There were no MSS bonds outstanding. Rise in currency in circulation on RBI easing limits on cash withdrawals and advance tax outflows brought down system liquidity.